Fed triggers lift-off with first hike since 2018

The move came as inflation in the United States hit a 40-year high of 7.9% in February. 

While the hike had been expected, the Fed had introduced a “hawkish surprise” with a shift in the dot plot, according to Nick Chatters, investment manager at Aegon Asset Management.

The Fed is now expecting seven hikes throughout this year. However, one member of the committee projected that the midpoint of rates will be over 3% by the end of 2022, while another predicted it will be less than 1.5%.

Chatters explained that the shift in the dot plot had caused a “move in markets, with front-end yields up, flatter curve and inflation breakevens down”.

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He added that the new dot plot was “quite punchy”, arguing that the “Fed that is now worried that it is behind the curve and wants to get back to neutral as soon as it possibly can, without upsetting the recovery.”

The Fed plans to follow a taper-hike-sell pattern as it begins tightening, with the taper of the quantitative easing programme ending in March as the Fed stopped purchases. 

The hike part of the plan began last week. The Fed previously stated that after several consecutive rate hikes, it will begin the process of selling off assets but has not yet announced when this will begin.

“The risk of a recession in the next year is not particularly elevated,” said chair Jerome Powell following the decision. “All signs are that this is a strong economy, one that will be able to flourish in the face of tighter monetary policy.”

However, the central bank also cut projections for US economic growth in 2022, bringing it from 4% in December last year to 2.8% now.

Salman Ahmed, global head of macro and strategic asset allocation at Fidelity International, argued that the move saw the Fed “resurrect Volkerism,” adding that he still thinks that the Fed will only hike three or four times this year and that “the ensuing tightening conditions from a very hawkish Fed will damage growth”.

However, other analysts argued that the Fed had not been hawkish enough, with Seema Shah, chief strategist at Principal Global Investors, adding that “probably six months after they should have started raising interest rates, the Fed has finally started lift-off”.

“With inflation already almost quadruple their target, the Fed is playing catch-up and clearly recognises the need to get back in front of the inflation situation,” she continued.

While Shah acknowledged some are worried that “the US economy is not sufficiently sturdy to digest that many increases,” she explained that the predicted increases would only take rates back to pre-pandemic levels, with households now “arguably in a considerably stronger state”.

Charles Hepworth, investment director of GAM Investments, agreed, stating that “while they may need to appear hawkish with now stubbornly high inflation, it is obvious that had the committee acted sooner they would not have needed to act so aggressively now. With a slowing economy and worsening financial conditions, it is highly unlikely that their projected trajectory will be delivered on.”

International sanctions on Russia and continuing supply shocks from the pandemic are expected to further add inflationary pressures over the next months. However, Silvia Dall’Angelo, senior economist for Federated Hermes, noted that this leaves the Fed “somewhat reactive rather than proactive” as these problems cannot be directly addressed by monetary policy.

“The war in Ukraine, the evolution of the growth-inflation trade-off and indications concerning second round effects for inflation, will dictate the pace of tightening going forward,” she concluded.

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